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Wednesday, July 28, 2010

Truly Patient Capital - How We Can Create Systemic Change – Part 2

In our last post we introduced our Pareto Holdings concept. Pareto is a socially oriented holding company that swaps Preferred Stock shares in nescient (but profitable) impact ventures for its own Common Shares. The thought is that a large holding company’s Common Shares will be increasingly more liquid than a single investors Preferred Shares in an early stage company.

If you missed that post, here’s the link. We ended the last post before fully describing how stakeholders will benefit from Pareto. So we will pick up with that here.

Pareto Holdings – Who Will Benefit

The point of Pareto Holdings is not to make a financial killing. The point is to create systemic change by proving that patient capital is sustainable, profitable and powerful. To achieve that, it must be efficient, pragmatic and focused. With that said, managers cannot forget who the beneficiaries are and why they needed Pareto in the first place.

Benefit for Entrepreneurs

Impact Entrepreneurs are in a difficult position. They seek profits but must consider impact. They target those in need but not to exploit their lack of options. In many cases they take on risks and expenses well beyond those accounted for by their direct competitors (see our post on Impact Maximization for more on that).

The current models for financing Impact Entrepreneurs are not growing as quickly as the number of entrepreneurs with exceptional socially motivated start-ups. Philanthropic dollars are adapting but will never meet the growing gap. Traditional investors are also adapting, but their expectations and focus on massive returns will keep them from providing the support that is needed.

Pareto could help meet the gap by encouraging more philanthropically minded investors and organizations to become Impact Angel (or seed stage) Investors. Currently, these players have no compelling options to bring them from the sidelines. Impactful equity investments present for-profit models that don’t fit traditional grant making qualifications and are far too risky for traditional Mission Related Investments[1]. The holding company model could create a third, more compelling reason for them to join in.

More importantly, Pareto could also change the relationship between investors and entrepreneurs. A long-term profit sharing focus is much more in-line with the day-to-day concerns of a business owner. Early stage investors are rightly focused on scale. It is much more important than profits in that it increases the likelihood of an exit event and they depend on exits for liquidity and profits. As a holding company, Pareto’s interests are proportionate to each company’s size and the focus is to make holdings sustainable and profitable over the long-term. That means impact entrepreneurs will start with the important focus on scale, then shift gears and focus on profits as they come under the umbrella of the Holding company.

Benefits for Impact Investors

Seed stage impact investors (or Impact Angels), the few that currently exist, are also in a difficult situation. They want to leverage their wealth to create lasting change. They want something more sustainable than charity but with more positive impact than traditional businesses. They want to help young ventures become successful enterprises but they don’t want them to forget their social missions in the process.They want to be active investors.

Pareto was designed with their dilemma in mind (after all, they are our clients). Impact Angels are the fuel for the emerging industry and we won’t get far without more of them. Yet convincing more to join the ranks is very difficult because there are no compelling exit strategies that meet their desired outcomes.The holding company model, with a proven commitment to positive impact, will create exits that meet their goal of getting a return on investment while keeping a careful eye on the original mission.

Benefits for Institutional Investors & Foundations

Exits are not the only benefit that Pareto will provide. Individuals and institutions currently lack liquid investments that are high impact (the do-good kind). Pareto will sell shares to impact investors that benefit from the diversity and stability of a large portfolio while maintaining a deep commitment to improving the lives of those less fortunate.Pareto’s support for Full Cost Accounting methods, direct impact and long-term growth will make it easy for investors to assess the impact of their funds (and easy to explain to their clients).

Pareto Holdings – Making It Happen

This is a very BIG idea and we are still a small company. As entrepreneurs our first inclination is to run out and try to make this happen on our own. As sensible human beings, we know better. We need to bat this idea around with other BIG thinkers in the industry so that it can take shape. In business the devil is in the details and Pareto has a lot of details.We need experts to weigh-in, warn us of potential pitfalls, and point us in the right direction. Finally, we need momentum. New ideas are hard to get moving, but once they do, momentum alone will take them far. As a small company, there is probably nothing more difficult for us to do than create momentum. All we can do is keep talking, keep writing and hope that some of you join us.

[1] Mission Related Investments (MRI) are a tool used by foundations to make mission oriented investments that seek returns. A quick guide (with links to guides) can be found here: http://bit.ly/cHT0lh